The Creation of Money and a Fiat Currency

Government 1B: Lesson 50

What is the origin of money?

For most, money is represented by the crisp new paper bills that are kept in wallets, the tap of a debit card, or the transfer of an email. For a few, money is remembered as precious metal coins that bore the stamp of the king, queen, or president. But even these people do not know what money is or how gold, silver, and metal coins came to be known all over the world as money. The origin of money did not start with a government stamping coins and declaring a new currency. Instead, money is a social phenomenon which people in a society gradually invent.

The function of money is to carry a value that can be used in the future. This does not work in a one-man society but has to be in a functioning society with people that have an ordered set of wants. These wants could be any goods or services which people wish to exchange. Barter, trade, or direct exchange works in a primitive society, or a very new society where people can trade one set of goods for another. However, once a society starts introducing new goods and services and the population grows, things become more complicated. Gone are the times of trading a sack of potatoes for a bushel of apples. People now have a long list of needs and wants and something they are willing to trade to obtain it, but that does not mean a man can find another individual that has everything he needs and who wants what he has in exchange.

Money is the solution to this overcomplicated problem. It simplifies barter and trade by becoming the most marketable commodity. People no longer have to find people with specific items to trade, and now everyone can simply “trade” for money. It becomes the most popular good because it can be used to obtain any other good.

Many things have been used throughout history as money, but for the currency to last in a functioning society, it must have 5 characteristics:

  1. Divisibility
  2.  Portability
  3.  Durability
  4.  Recognizability
  5.  Scarcity

Cattle were once used as a currency, but they clearly didn’t last long because they didn’t fit all the characteristics of money. A cow is not easily divisible or portable, and depending on where a person lives in the world it may or may not be scarce. Sea shells are another historic currency and while better than using cattle, shells are not very durable. The most widely used currency throughout history and the world has been gold and silver. Fitting all the characteristics of money it also has a high value per unit of weight.

Three disadvantages with fiat money.

The western world no longer has a gold standard – where every piece of issued paper money is backed by gold or silver – and society has been dealing with a fiat currency for decades. While there are some advantages to using paper instead of solid coins, there are three major disadvantages with a fiat currency.

Firstly, the boom-bust business cycle would not be possible without a fiat currency. Creating money, and then distributing it according to how it wants, is how the government increases its power. It can manipulate interest rates and lead the economy into thinking the market is doing something it’s not, so when the bust finally occurs the people rush to the government asking for help and willingly lay down more money and powers and continuing the vicious business cycle.

Second, fiat money can drop to zero value. Remember, that one of the advantages of using gold or silver as a commodity money, is that it holds a high value per unit or weight and has a value outside of the use of money. Paper money does not. Therefore, once there is inflation (and there always is inflation in a fiat currency economy) or even hyperinflation, the value of paper money can drop to zero, and once it hits zero it can never be revived. Commodity money has a use value, so it will never completely drop to zero.

Thirdly, a fiat currency makes it hard for anyone to save for the future. With precious metals, they can hold or increase value over time, making it very easy and logical for people to save up money. There is no need to worry that your gold coins will be worth something in the future because they will almost certainly hold their value. A paper fiat currency is incredibly difficult to save because it could be worth nothing tomorrow. It is a risk for a couple to save for retirement when the fiat money may lose all value by the time they need it. The smart thing to do would be to spend the fiat money when it is worth the most, however, trying to predict what the market will do is virtually impossible.

When the government holds a monopoly on the money supply, no longer holds a gold standard, inflates the currency at will, and artificially controls interest rates, society is on a fast track to disaster. The future becomes unpredictable and eventually, the system will crash so hard that there is nothing left for society to do than to throw out the old system and rebuild the economy from the ground up on solid, moral principles. But that is for a much longer essay another time.

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